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EX-32.1 - EXHIBIT 32.1 - SURREY BANCORPex32_1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the quarterly period ended March 31, 2016

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from ____________ to ___________

COMMISSION FILE NO. 000-50313

SURREY BANCORP
(Exact name of registrant as specified in its charter)

North Carolina
 
59-3772016
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)

145 North Renfro Street, Mount Airy, NC  27030
 (Address of principal executive offices)

(336) 783-3900
 (Registrant's telephone number)
 


Check whether the registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   ☒             No   

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes   ☒             No   ☐

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 
Large accelerated filer
Accelerated filer
         
 
Non-accelerated filer
Smaller reporting company

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   ☐          No   ☒

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date:

On May 12, 2016 there were 3,549,665 common shares issued and outstanding.
 


PART I – FINANCIAL INFORMATION
     
Item 1.
Consolidated Financial Statements
 
     
 
3
     
 
4
     
 
5
     
 
6
     
 
7
     
 
8-22
     
Item 2.
23-29
     
Item 3.
30
     
Item 4.
31
     
PART II – OTHER INFORMATION
     
Item 1.
32
     
Item 1A.
32
     
Item 2.
32
     
Item 3.
32
     
Item 4.
32
     
Item 5.
32
     
Item 6.
32
     
33
     
CERTIFICATIONS
34-36
 
Consolidated Balance Sheets
March 31, 2016 (Unaudited) and December 31, 2015 (Audited)

   
March
2016
   
December
2015
 
             
Assets
           
Cash and due from banks
 
$
7,041,151
   
$
5,874,561
 
Interest-bearing deposits with banks
   
23,462,068
     
32,921,125
 
Federal funds sold
   
1,221,172
     
1,217,801
 
Investment securities available for sale
   
5,316,724
     
5,340,743
 
Restricted equity securities
   
401,699
     
397,599
 
Loans, net of allowance for loan losses of $3,800,316 at March 31, 2016 and $3,626,908 at December 31, 2015
   
207,097,033
     
197,904,895
 
Property and equipment, net
   
5,313,551
     
5,333,066
 
Foreclosed assets
   
365,609
     
384,452
 
Accrued income
   
1,108,545
     
1,084,164
 
Goodwill
   
120,000
     
120,000
 
Bank owned life insurance
   
6,671,349
     
5,125,339
 
Other assets
   
2,426,128
     
2,072,810
 
Total assets
 
$
260,545,029
   
$
257,776,555
 
                 
Liabilities and Stockholders’ Equity
               
Liabilities
               
Deposits:
               
Noninterest-bearing
 
$
59,875,326
   
$
54,619,375
 
Interest-bearing
   
156,405,665
     
158,068,586
 
Total deposits
   
216,280,991
     
212,687,961
 
                 
Long-term debt
   
1,750,000
     
2,750,000
 
Dividends payable
   
45,227
     
1,004,642
 
Accrued interest payable
   
109,026
     
91,632
 
Other liabilities
   
2,930,472
     
2,571,350
 
Total liabilities
   
221,115,716
     
219,105,585
 
                 
Commitments and contingencies (Note 4)
               
                 
Stockholders’ equity
               
Preferred stock, 1,000,000 shares authorized,
               
189,356 shares of Series A issued and outstanding with no par value 4.5% convertible non-cumulative, perpetual, with a liquidation value of $14 per share;
   
2,620,325
     
2,620,325
 
181,154 shares of Series D issued and outstanding with no par value 5.0% convertible non-cumulative, perpetual; with a liquidation value of $7.08 per share;
   
1,248,482
     
1,248,482
 
Common stock, 10,000,000 shares authorized at no par value; 3,549,665 shares issued and outstanding at  March 31, 2016 and December 31, 2015
   
12,101,480
     
12,101,480
 
Retained earnings
   
23,459,314
     
22,727,587
 
Accumulated other comprehensive loss
   
(288
)
   
(26,904
)
Total stockholders’ equity
   
39,429,313
     
38,670,970
 
Total liabilities and stockholders’ equity
 
$
260,545,029
   
$
257,776,555
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Income
Three months ended March 31, 2016 and 2015 (Unaudited)

   
2016
   
2015
 
Interest income
           
Loans and fees on loans
 
$
2,873,063
   
$
2,679,309
 
Federal funds sold
   
1,266
     
691
 
Investment securities available for sale, taxable
   
22,782
     
16,807
 
Investment securities available for sale, dividends
   
649
     
2,234
 
Deposits with banks
   
30,856
     
20,837
 
Total interest income
   
2,928,616
     
2,719,878
 
                 
Interest expense
               
Deposits
   
212,348
     
236,397
 
Long-term debt
   
20,867
     
60,705
 
Total interest expense
   
233,215
     
297,102
 
Net interest income
   
2,695,401
     
2,422,776
 
                 
Provision for (recapture of) loan losses
   
75,814
     
(113,794
)
Net interest income after provision for (recapture of) loan losses
   
2,619,587
     
2,536,570
 
                 
Noninterest income
               
Service charges on deposit accounts
   
160,977
     
191,344
 
Fees on loans delivered to correspondents
   
7,194
     
5,646
 
Other service charges and fees
   
180,185
     
171,193
 
Gain (loss) on the sale of investment securities
   
(33,127
)
   
4,376
 
Income from bank owned life insurance
   
46,010
     
36,824
 
Insurance commissions
   
100,911
     
83,777
 
Brokerage commissions
   
14,681
     
79,041
 
Other operating income
   
61,726
     
53,033
 
Total noninterest income
   
538,557
     
625,234
 
                 
Noninterest expense
               
Salaries and employee benefits
   
1,078,058
     
1,032,331
 
Occupancy expense
   
129,093
     
109,348
 
Equipment expense
   
68,451
     
62,896
 
Data processing
   
129,576
     
123,006
 
Foreclosed assets, net
   
34,031
     
38,844
 
Postage, printing and supplies
   
43,479
     
41,324
 
Professional fees
   
17,703
     
141,999
 
FDIC insurance premiums
   
32,515
     
24,458
 
Other expense
   
422,683
     
458,462
 
Total noninterest expense
   
1,955,589
     
2,032,668
 
Net income before income taxes
   
1,202,555
     
1,129,136
 
                 
Income tax expense
   
425,601
     
400,702
 
Net income
   
776,954
     
728,434
 
                 
Preferred stock dividends
   
(45,227
)
   
(45,227
)
Net income available to common stockholders
 
$
731,727
   
$
683,207
 
                 
Basic earnings per common share
 
$
0.21
   
$
0.19
 
Diluted earnings per common share
 
$
0.19
   
$
0.17
 
Basic weighted average common shares outstanding
   
3,549,665
     
3,549,665
 
Diluted weighted average common shares outstanding
   
4,183,600
     
4,187,410
 

See Notes to Consolidated Financial Statements
 
Consolidated Statements of Comprehensive Income
Three months ended March 31, 2016 and 2015 (Unaudited)

   
2016
   
2015
 
             
Net income
 
$
776,954
   
$
728,434
 
                 
Other comprehensive income:
               
Investment securities available for sale:
               
Unrealized holding gains
   
7,455
     
12,825
 
Tax effect
   
(2,703
)
   
(4,801
)
Reclassification of (gains) losses recognized in net income
   
33,127
     
(4,376
)
Tax effect
   
(11,263
)
   
1,488
 
     
26,616
     
5,136
 
Comprehensive income
 
$
803,570
   
$
733,570
 

See Notes to Consolidated Financial Statements
 
Consolidated Statements of Cash Flows
Three months ended March 31, 2016 and 2015 (Unaudited)

   
2016
   
2015
 
Cash flows from operating activities
           
Net income
 
$
776,954
   
$
728,434
 
Adjustments to reconcile net income to net cash provided by operations:
               
Depreciation and amortization
   
73,755
     
67,627
 
Gain on sale of property and equipment
   
(10
)
   
(50
)
(Gain) loss on the sale of securities
   
33,127
     
(4,376
)
Loss on the sale of foreclosed assets
   
-
     
8,507
 
Write down of foreclosed assets
   
25,048
     
-
 
Provision (recapture) of loan losses
   
75,814
     
(113,794
)
Deferred income tax benefit
   
(7,199
)
   
(2,071
)
Accretion of discount on securities, net of amortization of premiums
   
(211
)
   
(103
)
Increase in cash surrender value of life insurance
   
(46,010
)
   
(36,824
)
Life insurance proceeds
   
-
     
1,001,320
 
Changes in assets and liabilities:
               
Accrued income
   
(24,381
)
   
(3,487
)
Other assets
   
(360,085
)
   
91,210
 
Accrued interest payable
   
17,394
     
22,809
 
Other liabilities
   
359,122
     
(60,807
)
Net cash provided by operating activities
   
923,318
     
1,698,395
 
                 
Cash flows from investing activities
               
Net (increase) decrease in interest-bearing deposits with banks
   
9,459,057
     
(5,309,402
)
Net increase in federal funds sold
   
(3,371
)
   
(2,231
)
Purchases of investment securities
   
(1,500,516
)
   
(1,009,610
)
Maturities of investment securities
   
1,001,483
     
1,001,578
 
Purchase of restricted equity securities
   
(4,100
)
   
(11,100
)
Net (increase) decrease in loans
   
(9,289,032
)
   
481,474
 
Proceeds from the sale of investment securities
   
530,718
     
11,135
 
Proceeds from the sale of foreclosed assets
   
14,875
     
136,924
 
Purchases of property and equipment
   
(54,240
)
   
(244,800
)
Purchase of bank owned life insurance
   
(1,500,000
)
   
-
 
Proceeds from the sale of property and equipment
   
10
     
50
 
Net cash used in investing activities
   
(1,345,116
)
   
(4,945,982
)
                 
Cash flows from financing activities
               
Net increase in deposits
   
3,593,030
     
3,239,968
 
Maturity of long-term debt
   
(1,000,000
)
   
-
 
Dividends paid
   
(1,004,642
)
   
(827,159
)
Net cash provided by financing activities
   
1,588,388
     
2,412,809
 
Net increase (decrease) in cash and cash equivalents
   
1,166,590
     
(834,778
)
Cash and due from banks, beginning
   
5,874,561
     
6,236,749
 
Cash and due from banks, ending
 
$
7,041,151
   
$
5,401,971
 
                 
Supplemental disclosures of cash flow information
               
Interest paid
 
$
215,821
   
$
274,293
 
Taxes paid
 
$
-
   
$
-
 
Supplemental disclosures of non-cash transactions
               
Loans transferred to foreclosed properties
 
$
21,080
   
$
40,136
 
Cash dividends declared but not paid
 
$
45,227
   
$
45,227
 

See Notes to Consolidated Financial Statements
 
Consolidated Statements of Changes in Stockholders’ Equity
Three months ended March 31, 2016 and 2015 (Unaudited)

     
Preferred
Stock
   
Common Stock
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
       
   
Amount
   
Shares
   
Amount
       
Income (Loss)
   
Total
 
                                     
Balance, January 1, 2015
 
$
3,868,807
     
3,549,665
   
$
12,101,480
   
$
20,808,309
   
$
(7,942
)
 
$
36,770,654
 
                                                 
Net income
   
-
     
-
     
-
     
728,434
     
-
     
728,434
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
5,136
     
5,136
 
                                                 
Dividends declared and accrued on convertible Series A preferred stock ($.16 per share)
   
-
     
-
     
-
     
(29,415
)
   
-
     
(29,415
)
Dividends declared and accrued on convertible Series D preferred stock ($.09 per share)
   
-
     
-
     
-
     
(15,812
)
   
-
     
(15,812
)
Balance, March 31, 2015
 
$
3,868,807
     
3,549,665
   
$
12,101,480
   
$
21,491,516
   
$
(2,806
)
 
$
37,458,997
 
                                                 
Balance, January 1, 2016
 
$
3,868,807
     
3,549,665
   
$
12,101,480
   
$
22,727,587
   
$
(26,904
)
 
$
38,670,970
 
                                                 
Net income
   
-
     
-
     
-
     
776,954
     
-
     
776,954
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
26,616
     
26,616
 
                                               
Dividends declared and accrued on convertible Series A preferred stock ($.16 per share)
   
-
     
-
     
-
     
(29,415
)
   
-
     
(29,415
)
Dividends declared and accrued on convertible Series D preferred stock ($.09 per share)
   
-
     
-
     
-
     
(15,812
)
   
-
     
(15,812
)
Balance, March 31, 2016
 
$
3,868,807
     
3,549,665
   
$
12,101,480
   
$
23,459,314
   
$
(288
)
 
$
39,429,313
 

See Notes to Consolidated Financial Statements
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures required by generally accepted accounting principles for a complete presentation of financial statements. In the opinion of management, the consolidated financial statements contain all adjustments necessary to present fairly the financial condition of Surrey Bancorp, (the “Company), as of March 31, 2016, the results of its operations and comprehensive income for the three months ended March 31, 2016 and 2015, and its changes in stockholders’ equity and cash flows for the three months ended March 31, 2016 and 2015.  These adjustments are of a normal and recurring nature. The results of operations for the three months ended March 31, 2016, are not necessarily indicative of the results expected for the full year. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and related disclosures for the year ended December 31, 2015, included in the Company’s Form 10-K. The balance sheet at December 31, 2015, has been taken from the audited financial statements at that date.

Organization

Surrey Bancorp began operation on May 1, 2003 and was created for the purpose of acquiring all the outstanding shares of common stock of Surrey Bank & Trust (“the Bank”). Stockholders of the bank received six shares of Surrey Bancorp common stock for every five shares of Surrey Bank & Trust common stock owned. The Company is subject to regulation by the Federal Reserve.

Surrey Bank & Trust was organized and incorporated under the laws of the State of North Carolina on July 15, 1996 and commenced operations on July 22, 1996. The Bank currently serves Surry County, North Carolina and Patrick County, Virginia and surrounding areas through five banking offices. As a state chartered bank, which is not a member of the Federal Reserve, the Bank is subject to regulation by the State of North Carolina Banking Commission and the Federal Deposit Insurance Corporation.

Surrey Investment Services, Inc., (“Subsidiary”) was organized and incorporated under the laws of the State of North Carolina on February 10, 1998. The subsidiary provides insurance services through SB&T Insurance and investment advice and brokerage services through LPL Financial.

On July 31, 2000, Surrey Bank & Trust formed Freedom Finance, LLC, a subsidiary operation specializing in the purchase of sales finance contracts from local automobile dealers.

The accounting and reporting policies of the Company, the Bank, and its subsidiaries follow generally accepted accounting principles and general practices within the financial services industry. Following is a summary of the more significant policies.

Critical Accounting Policies

The notes to the audited consolidated financial statements for the year ended December 31, 2015 contain a summary of the significant accounting policies.  The Company believes our policies with respect to the methodology for the determination of the allowance for loan losses, and asset impairment judgments, including the recoverability of intangible assets involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters.  Changes in these judgments, assumptions or estimates could cause reported results to differ materially.  These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors.  See our Annual Report on Form 10-K for full details on critical accounting policies.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, the Bank and the subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION, CONTINUED

Presentation of Cash Flows

For purposes of reporting cash flows, cash and cash equivalents includes cash and amounts due from depository institutions (including cash items in process of collection). Overnight interest bearing deposits and federal funds sold are shown separately.  Federal funds purchased are shown with securities sold under agreements to repurchase.

Investment Securities

Investments classified as available for sale are intended to be held for indefinite periods of time and include those securities that management may employ as part of asset/liability strategy or that may be sold in response to changes in interest rates, prepayments, regulatory capital requirements or similar factors. These securities are carried at fair value and are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or significant other observable inputs.

Investment securities classified as held to maturity are those debt securities that the Bank has the ability and intent to hold to maturity. Accordingly, these securities are carried at cost adjusted for amortization of premiums and accretion of discount, computed by the interest-method over their contractual lives. At March 31, 2016 and December 31, 2015, the Bank had no investments classified as held to maturity.

Loans Held for Sale

The Bank originates and holds Small Business Administration (SBA) and United States Department of Agriculture (USDA) guaranteed loans in its portfolio in the normal course of business. Occasionally, the Bank sells the guaranteed portions of these loans into the secondary market. The loans are generally variable rate loans, which eliminates the market risk to the Bank and are therefore carried at cost. Fixed rate loans are carried at the lower of cost or market. The Bank recognizes gains on the sale of the guaranteed portion upon the consummation of the transaction. The Bank plans to continue to originate guaranteed loans for sales, however no such loans were funded and held for sale at March 31, 2016 and December 31, 2015.

Loans Receivable

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal amount adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or cost on originated loans and unamortized premiums or discounts on purchased loans.

Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan using the interest method.  Discounts and premiums on any purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments.  Discounts and premiums on any purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method.

Interest is accrued and credited to income based on the principal amount outstanding.  The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.  When the interest accrual is discontinued, all unpaid accrued interest is reversed.  Interest income is subsequently recognized only to the extent cash payments are received.  Payments received on nonaccrual loans are first applied to principal and any residual amounts are then applied to interest.  When facts and circumstances indicate the borrower has regained the ability to meet the required payments, the loan is returned to accrual status.  Past due loans are determined on the basis of contractual terms.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION, CONTINUED

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components.  The specific component relates to loans that are classified as impaired.  For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.

Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

In February 2016, the FASB issued new guidance to change accounting for leases and that will generally require most leases to be recognized on the balance sheet. The new lease standard only contains targeted changes to accounting by lessors, however, lessees will be required to recognize most leases in their balance sheets as lease liabilities for lease payments and right-of-use assets representing the lessee's rights to use the underlying assets for the lease terms for lease arrangements longer than 12 months. Under this approach, a lessee will account for most existing capital/finance leases as Type A leases and most existing operating leases as Type B leases. Type A and Type B leases have unique accounting and disclosure requirements. Existing sale-leaseback guidance, including guidance for real estate, will be replaced with a new model applicable to both lessees and lessors The new guidance will be effective for fiscal years (and interim periods within those fiscal years) beginning after December 15, 2018. Early adoption is permitted for all companies and organizations. Management is currently analyzing the impact of the adoption of this guidance on the Company's financial statements, including assessing changes that might be necessary to information technology systems, processes and internal controls to capture new data and address changes in financial reporting.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION, CONTINUED

Recent Accounting Pronouncements, continued

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows.  Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments will be effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect these amendments to have a material effect on its financial statements.

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued.  Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.  Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.  Management has reviewed events occurring through the date the financial statements were issued and no subsequent events have occurred requiring accrual or disclosure.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. SECURITIES

Debt and equity securities have been classified in the balance sheets according to management’s intent.  The amortized costs of securities available for sale and their approximate fair values at March 31, 2016 and December 31, 2015 follow:

   
Amortized
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                         
March 31, 2016
                       
Government-sponsored enterprises
 
$
4,998,434
   
$
3,175
   
$
3,729
   
$
4,997,880
 
Mortgage-backed securities
   
18,746
     
398
     
-
     
19,144
 
Corporate bonds
   
300,000
     
-
     
300
     
299,700
 
   
$
5,317,180
   
$
3,573
   
$
4,029
   
$
5,316,724
 
                                 
December 31, 2015
                               
Government-sponsored enterprises
 
$
4,498,227
   
$
3,130
   
$
10,117
   
$
4,491,240
 
Mortgage-backed securities
   
20,233
     
446
     
-
     
20,679
 
Corporate bonds
   
300,000
     
-
     
300
     
299,700
 
Equities and mutual funds
   
563,321
     
14,644
     
48,841
     
529,124
 
   
$
5,381,781
   
$
18,220
   
$
59,258
   
$
5,340,743
 

At March 31, 2016 and December 31, 2015, substantially all government-sponsored enterprises securities were pledged as collateral on public deposits and for other purposes as required or permitted by law.  The mortgage-backed securities were pledged to the Federal Home Loan Bank.

Maturities of mortgage-backed bonds are stated based on contractual maturities.  Actual maturities of these bonds may vary as the underlying mortgages are prepaid.  The investment in equities and mutual funds by nature have no maturity date and are classified as due in one year or less. The scheduled maturities of securities (all available for sale) at March 31, 2016, were as follows:

   
Amortized
Cost
   
Fair
Value
 
Due in one year or less
 
$
500,000
   
$
499,655
 
Due after one year through five years
   
4,809,160
     
4,808,828
 
Due after five years through ten years
   
-
      -  
Due after ten years
   
8,020
     
8,241
 
   
$
5,317,180
   
$
5,316,724
 

The following table shows investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at March 31, 2016 and December 31, 2015. These unrealized losses on investment securities are a result of volatility in interest rates which relate to government-sponsored enterprises and corporate bonds issued by other banks at March 31, 2016 and December 31, 2015, and market volatility as it relates to equity and mutual fund investments at December 31, 2015.

   
Less Than 12 Months
   
12 Months or More
   
Total
 
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
                                     
March 31, 2016
                                   
Government-sponsored enterprises
 
$
1,995,050
   
$
3,384
   
$
499,655
   
$
345
   
$
2,494,705
   
$
3,729
 
Corporate bonds
   
-
     
-
     
299,700
     
300
     
299,700
     
300
 
   
$
1,995,050
   
$
3,384
   
$
799,355
   
$
645
   
$
2,794,405
   
$
4,029
 
                                                 
December 31, 2015
                                               
Government-sponsored enterprises
 
$
2,488,110
   
$
10,117
   
$
-
   
$
-
   
$
2,488,110
   
$
10,117
 
Corporate bonds
   
-
     
-
     
299,700
     
300
     
299,700
     
300
 
Equities and mutual funds
   
63,865
     
22,785
     
41,140
     
26,056
     
105,005
     
48,841
 
   
$
2,551,975
   
$
32,902
   
$
340,840
   
$
26,356
   
$
2,892,815
   
$
59,258
 
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. SECURITIES, CONTINUED

Management considers the nature of the investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Based upon this evaluation, there are two securities in the portfolio at March 31, 2016, with unrealized losses for a period greater than 12 months. One of these securities also had unrealized losses for a period greater than 12 months at December 31, 2015. We have analyzed each individual security for Other Than Temporary Impairment (“OTTI”) purposes by reviewing delinquencies, loan-to-value ratios, and credit quality and concluded that all unrealized losses presented in the tables above are not related to an issuer’s financial condition but are due to changes in the level of interest rates and no declines are deemed to be other than temporary in nature.

The Company had realized losses of $33,127 from the sales of equity and mutual fund investment securities for the three month period ended March 31, 2016, and realized gains of $4,376 from the sales of equity and mutual fund investment securities for the three month periods ended March 31, 2015. Total proceeds from the sales amounted to $530,718 and $11,135 in 2016 and 2015, respectively.

NOTE 3. EARNINGS PER COMMON SHARE

Basic earnings per common share for the three months ended March 31, 2016 and 2015 were calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period.

The computation of diluted earnings per common share is similar to the computation of basic earnings per common share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares. The potential dilutive shares are represented by common stock options and by the Series A and D convertible preferred stock. Each share of the Series A preferred is convertible into 2.2955 shares of common stock. Each share of Series D preferred is convertible into 1.10 shares of common stock.

NOTE 4. COMMITMENTS AND LETTERS OF CREDIT

At March 31, 2016, the Company had commitments to extend credit, including unused lines of credit of approximately $43,674,000 and letters of credit outstanding of $2,801,841.

NOTE 5. LOANS

The major components of loans in the balance sheets at March 31, 2016 and December 31, 2015 are below.

   
2016
   
2015
 
             
Commercial
 
$
55,375,294
   
$
51,930,870
 
Real estate:
               
Construction and land development
   
9,613,485
     
9,669,380
 
Residential, 1-4 families
   
43,710,878
     
43,830,689
 
Residential, 5 or more families
   
1,126,153
     
1,155,535
 
Farmland
   
6,243,947
     
6,043,944
 
Nonfarm, nonresidential
   
88,623,068
     
82,595,636
 
Agricultural
   
1,473,015
     
1,609,150
 
Consumer, net of discounts of $13,915 in 2016 and $11,950 in 2015
   
4,508,500
     
4,532,179
 
     
210,674,340
     
201,367,383
 
Deferred loan origination costs, net of (fees)
   
223,009
     
164,420
 
   
210,897,349
     
201,531,803
 
Allowance for loan losses
   
(3,800,316
)
   
(3,626,908
)
   
$
207,097,033
   
$
197,904,895
 
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5. LOANS, CONTINUED

Residential, 1-4 family loans pledged as collateral against FHLB advances approximated $12,314,000 and $12,691,000 at March 31, 2016 and December 31, 2015, respectively.

NOTE 6. ALLOWANCE FOR LOAN LOSSES

The activity of the allowance for loan losses by loan components during the three months ended March 31, 2016 and 2015 was as follows:

 
Construction
&
Development
   
1-4 Family
Residential
   
Nonfarm,
Nonresidential
   
Commercial
&
Industrial
   
Consumer
   
Other
   
Total
 
                                           
March 31, 2016
                                         
                                           
Allowance for credit losses:
                                     
Beginning balance
 
$
150,400
   
$
790,200
   
$
1,020,400
   
$
1,361,814
   
$
177,894
   
$
126,200
   
$
3,626,908
 
Charge-offs
   
-
     
(62,665
)
   
-
     
(5,129
)
   
(15,595
)
   
(17,317
)
   
(100,706
)
Recoveries
   
-
     
7,025
     
4,584
     
181,939
     
2,423
     
2,329
     
198,300
 
Provision
   
(200
)
   
64,940
     
153,116
     
(188,624
)
   
(82,122
)
   
128,704
     
75,814
 
Ending balance
 
$
150,200
   
$
799,500
   
$
1,178,100
   
$
1,350,000
   
$
82,600
   
$
239,916
   
$
3,800,316
 
                                                         
Ending balance: individually evaluated for impairment
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
Ending balance: collectively evaluated for impairment
 
$
150,200
   
$
799,500
   
$
1,178,100
   
$
1,350,000
   
$
82,600
   
$
239,916
   
$
3,800,316
 
                                                         
Loans Receivable:
                                                   
Ending balance
 
$
9,613,485
   
$
43,710,878
   
$
88,623,068
   
$
55,375,294
   
$
4,508,500
   
$
8,843,115
   
$
210,674,340
 
                                                         
Ending balance: individually evaluated for impairment
 
$
10,380
   
$
1,016,089
   
$
2,209,087
   
$
2,113,933
   
$
-
   
$
5,543
   
$
5,355,032
 
Ending balance: collectively evaluated for impairment
 
$
9,603,105
   
$
42,694,789
   
$
86,413,981
   
$
53,261,361
   
$
4,508,500
   
$
8,837,572
   
$
205,319,308
 
                                                         
March 31, 2015
                                                       
                                                         
Allowance for credit losses:
                                                   
Beginning balance
 
$
160,100
   
$
798,199
   
$
1,067,315
   
$
1,301,900
   
$
158,750
   
$
68,400
   
$
3,554,664
 
Charge-offs
   
-
     
(47,169
)
   
-
     
(897
)
   
(35,562
)
   
-
     
(83,628
)
Recoveries
   
-
     
889
     
205
     
49,023
     
12,549
     
-
     
62,666
 
Provision
   
(68,000
)
   
28,773
     
35,371
     
(137,135
)
   
22,997
     
4,200
     
(113,794
)
Ending balance
 
$
92,100
   
$
780,692
   
$
1,102,891
   
$
1,212,891
   
$
158,734
   
$
72,600
   
$
3,419,908
 
                                                         
Ending balance: individually evaluated for impairment
 
$
-
   
$
64,992
   
$
113,491
   
$
143,291
   
$
-
   
$
-
   
$
321,774
 
Ending balance: collectively evaluated for impairment
 
$
92,100
   
$
715,700
   
$
989,400
   
$
1,069,600
   
$
158,734
   
$
72,600
   
$
3,098,134
 
                                                         
Loans Receivable:
                                                   
Ending balance
 
$
5,788,579
   
$
42,097,111
   
$
81,314,177
   
$
52,969,456
   
$
4,743,081
   
$
5,523,054
   
$
192,435,458
 
                                                         
Ending balance: individually evaluated for impairment
 
$
12,953
   
$
706,295
   
$
2,904,189
   
$
1,052,132
   
$
-
   
$
242,361
   
$
4,917,930
 
Ending balance: collectively evaluated for impairment
 
$
5,775,626
   
$
41,390,816
   
$
78,409,988
   
$
51,917,324
   
$
4,743,081
   
$
5,280,693
   
$
187,517,528
 
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

The following table presents impaired loans individually evaluated by class of loan as of March 31, 2016 and December 31, 2015 and the recognized interest income per the related period:

   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
                               
March 31, 2016
                             
With no related allowance recorded:
                             
Construction and development
 
$
10,379
   
$
10,379
   
$
-
   
$
10,789
   
$
219
 
1-4 family residential
   
1,016,090
     
1,088,244
     
-
     
1,071,681
     
19,750
 
Nonfarm, nonresidential
   
2,209,087
     
2,209,087
     
-
     
2,237,236
     
28,131
 
Commercial and industrial
   
2,113,933
     
2,116,629
     
-
     
2,117,249
     
34,606
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
5,543
     
11,086
     
-
     
10,964
     
-
 
     
5,355,032
     
5,435,425
     
-
     
5,447,919
     
82,706
 
                                         
With an allowance recorded:
                                       
Construction and development
   
-
     
-
     
-
     
-
     
-
 
1-4 family residential
   
-
     
-
     
-
     
-
     
-
 
Nonfarm, nonresidential
   
-
     
-
     
-
     
-
     
-
 
Commercial and industrial
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
     
-
     
-
     
-
     
-
     
-
 
                                         
Combined:
                                       
Construction and development
   
10,379
     
10,379
     
-
     
10,789
     
219
 
1-4 family residential
   
1,016,090
     
1,088,244
     
-
     
1,071,681
     
19,750
 
Nonfarm, nonresidential
   
2,209,087
     
2,209,087
     
-
     
2,237,236
     
28,131
 
Commercial and industrial
   
2,113,933
     
2,116,629
     
-
     
2,117,249
     
34,606
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
5,543
     
11,086
     
-
     
10,964
     
-
 
   
$
5,355,032
   
$
5,435,425
   
$
-
   
$
5,447,919
   
$
82,706
 
                                         
December 31, 2015
                                       
With no related allowance recorded:
                                       
Construction and development
 
$
11,061
   
$
11,061
   
$
-
   
$
11,408
   
$
1,005
 
1-4 family residential
   
966,420
     
975,909
     
-
     
966,971
     
47,320
 
Nonfarm, nonresidential
   
2,640,143
     
2,640,143
     
-
     
2,542,346
     
99,820
 
Commercial and industrial
   
1,676,119
     
1,676,119
     
-
     
1,647,548
     
86,843
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
11,085
     
11,085
     
-
     
11,085
     
591
 
     
5,304,828
     
5,314,317
     
-
     
5,179,358
     
235,579
 
                                         
With an allowance recorded:
                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
1-4 family residential
   
-
     
-
     
-
     
-
     
-
 
Nonfarm, nonresidential
   
-
     
-
     
-
     
-
     
-
 
Commercial and industrial
   
592,557
     
592,557
     
45,014
     
592,557
     
37,304
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
     
592,557
     
592,557
     
45,014
     
592,557
     
37,304
 
                                         
Combined:
                                       
Construction and development
 
$
11,061
   
$
11,061
   
$
-
   
$
11,408
   
$
1,005
 
1-4 family residential
   
966,420
     
975,909
     
-
     
966,971
     
47,320
 
Nonfarm, nonresidential
   
2,640,143
     
2,640,143
     
-
     
2,542,346
     
99,820
 
Commercial and industrial
   
2,268,676
     
2,268,676
     
45,014
     
2,240,105
     
124,147
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
11,085
     
11,085
     
-
     
11,085
     
591
 
   
$
5,897,385
   
$
5,906,874
   
$
45,014
   
$
5,771,915
   
$
272,883
 
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

The following presents by class, an aging analysis of the recorded investment in loans.

   
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days Plus
Past Due
   
Total
Past Due
   
Current
   
Total
Financing
Receivables
   
Recorded
 Investment
> 90 Days
and
Accruing
 
March 31, 2016
                                         
                                           
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
9,613,485
   
$
9,613,485
   
$
-
 
1-4 family residential
   
292,683
     
17,975
     
319,279
     
629,937
     
43,080,941
     
43,710,878
     
9,470
 
Nonfarm, nonresidential
   
646,577
     
46,848
     
157,905
     
851,330
     
87,771,738
     
88,623,068
     
-
 
Commercial and industrial
   
697,381
     
125,861
     
9,496
     
832,738
     
54,542,556
     
55,375,294
     
-
 
Consumer
   
130,913
     
29,943
     
17,638
     
178,494
     
4,330,006
     
4,508,500
     
16,516
 
Other loans
   
-
     
-
     
5,543
     
5,543
     
8,837,572
     
8,843,115
     
-
 
Total
 
$
1,767,554
   
$
220,627
   
$
509,861
   
$
2,498,042
   
$
208,176,298
   
$
210,674,340
   
$
25,986
 
Percentage of total loans
   
0.84
%
   
0.10
%
   
0.24
%
   
1.19
%
   
98.81
%
   
100.00
%
       
                                                         
Non-accruals included above
                                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
         
1-4 family residential
   
-
     
-
     
309,808
     
309,808
     
460,471
     
770,279
         
Nonfarm, nonresidential
   
-
     
-
     
157,905
     
157,905
     
153,456
     
311,361
         
Commercial and industrial
   
-
     
-
     
9,496
     
9,496
     
-
     
9,496
         
Consumer
   
-
     
-
     
1,122
     
1,122
     
-
     
1,122
         
Other loans
   
-
     
-
     
5,543
     
5,543
     
-
     
5,543
         
   
$
-
   
$
-
   
$
483,874
   
$
483,874
   
$
613,927
   
$
1,097,801
         
                                                         
December 31, 2015
                                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
9,669,380
   
$
9,669,380
   
$
-
 
1-4 family residential
   
412,158
     
395,682
     
277,572
     
1,085,412
     
42,745,277
     
43,830,689
     
-
 
Nonfarm, nonresidential
   
487,300
     
120,590
     
320,924
     
928,814
     
81,666,822
     
82,595,636
     
3,502
 
Commercial and industrial
   
72,259
     
748,958
     
193,165
     
1,014,382
     
50,916,488
     
51,930,870
     
7,866
 
Consumer
   
62,137
     
72,140
     
27,242
     
161,519
     
4,370,660
     
4,532,179
     
26,120
 
Other loans
   
-
     
11,085
     
-
     
11,085
     
8,797,544
     
8,808,629
     
-
 
Total
 
$
1,033,854
   
$
1,348,455
   
$
818,903
   
$
3,201,212
   
$
198,166,171
   
$
201,367,383
   
$
37,488
 
Percentage of total loans
   
0.51
%
   
0.67
%
   
0.41
%
   
1.59
%
   
98.41
%
   
100.00
%
       
                                                         
Non-accruals included above
                                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
         
1-4 family residential
   
-
     
-
     
277,572
     
277,572
     
248,468
     
526,040
         
Nonfarm, nonresidential
   
62,070
     
49,503
     
317,421
     
428,994
     
51,445
     
480,439
         
Commercial and industrial
   
-
     
-
     
185,300
     
185,300
     
-
     
185,300
         
Consumer
   
-
     
-
     
1,122
     
1,122
     
-
     
1,122
         
Other loans
   
-
     
-
     
-
     
-
     
-
     
-
         
   
$
62,070
   
$
49,503
   
$
781,415
   
$
892,988
   
$
299,913
   
$
1,192,901
         

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. Loans classified as substandard or special mention are reviewed quarterly by the Company for further impairment or improvement to determine if appropriately classified. All other loans greater than $500,000, commercial lines greater than $250,000 and personal lines of credit greater than $100,000, and unsecured loans greater than $100,000 are specifically reviewed at least annually to determine the appropriate loan grading. In addition, during the renewal process of any loan, as well as when a loan becomes past due, the Company will evaluate the loan grade.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

Loans excluded from the scope of the annual review process above are generally classified as pass credits until: (a) they become past due; (b) management becomes aware of deterioration in the credit worthiness of the borrower; or (c) the customer contacts the Company for a modification. In these circumstances, the loan is specifically evaluated for potential classification as to special mention, substandard or even charged off. The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans by credit quality indicator are provided in the following table.

   
Total
   
Pass Credits
   
Special
Mention
   
Substandard
   
Doubtful
 
                               
March 31, 2016
                             
                               
Construction and development
 
$
9,613,485
   
$
9,613,485
   
$
-
   
$
-
   
$
-
 
1-4 family residential
   
43,710,878
     
42,820,067
     
676,885
     
213,926
     
-
 
Nonfarm, nonresidential
   
88,623,068
     
87,019,567
     
1,603,501
     
-
     
-
 
Commercial and industrial
   
55,375,294
     
53,364,059
     
2,008,539
     
2,696
     
-
 
Consumer
   
4,508,500
     
4,497,867
     
10,633
     
-
     
-
 
Other loans
   
8,843,115
     
8,837,572
     
-
     
5,543
     
-
 
   
$
210,674,340
   
$
206,152,617
   
$
4,299,558
   
$
222,165
   
$
-
 
                                         
Percentage of total loans
   
100.0
%
   
97.9
%
   
2.0
%
   
0.1
%
   
-
%
                                         
Guaranteed portion of loans